Economics of Putin’s victory

In 1998, Boris Yeltsin bowed out of office with the Russian economy in ruins. The Indian Left gleefully attributed this to rapid economic liberalisation.

Five years later, after even more liberalisation by Vladimir Putin, the Soviet economy has staged a remarkable recovery and become one of the fastest growing in the world. Voters have responded by giving Putin a resounding election victory.

The election was marred by excesses like using state media to promote Putin’s favoured parties, instead of giving equal time to all parties, as mandated by law. Despite such distortions, it seems clear that Putin is highly popular despite (or perhaps because of) his strong-arm tactics.

Putin boasts of three main achievements. First, he rescued Russia from the chaos of Yeltsin’s days, and restored order. Second, he put the oligarch’s businessmen — who had gained control of privatised giant companies in Yeltsin’s time — in their place, and jailed the biggest of them, Khodorkovsky.

Third, he carried economic reform forward, and became world-famous for his flat income tax.

Readers might think that his squashing of oligarchs made him a socialist. Not so. The USA cracks down on mafia businessmen and cartels even more heavily than Putin. The aim of economic reform is to create a competitive economy, not oligarchy.

In the 1996 US election, an ultra-right wing candidate for the Republican nomination, Steve Forbes, suggested a flat income tax. He fell by the wayside, with many saying that the USA could not stomach such extreme right-wing prescriptions.

Well, Forbes wanted a flat tax of 17 per cent. Putin opted for a flat tax of just 13 per cent, down from a top rate of 30 per cent. In fiscal policy, at least, Putin is to the right of Forbes.

What is more, he proved Forbes’ claim that a low flat tax could yield far more revenue by inducing far better compliance. Income tax collection in Russia rose from $6.2 billion in 2000 to almost $12 billion in 2002.

Moreover Putin cut corporate tax from 35 per cent to 24 per cent, and further to 15 per cent for small businesses. The economy boomed in consequence, and the budget has gone from deficit to surplus.

Other factors helped too. Oil prices collapsed from $30 a barrel in 1991 to $10 a barrel in 1998, hurting Yeltsin’s revenues. Now they have bounced back to $30, aiding Putin.

More important has been Putin’s re-establishment of state authority. The break-up of the Soviet Union led to chaos, the government could not collect taxes or pay salaries, and state governments refused to remit taxes to Moscow .

So Yeltsin just printed money to finance spending, creating a hyper inflation that destroyed the savings of the middle class. This was not free market economics but economic collapse induced by political collapse. Putin has restored political order, and hence economic order, by using undemocratic but effective strong-arm tactics against opponents.

The old accusation that Yeltsin liberalised too fast can be proved by objective criteria to be a fantasy. The Wall Street Journal and Heritage Foundation bring out an annual Index of Economic Freedom, and Russia always ranks low on this. Of the 156 countries ranked in 2003, Russia came as low as 135, jointly with Vietnam and Congo ! Even India had a higher position at 119.

The fact is that rule of law is very uncertain in Russia , and businessmen can be expropriated or jailed if they run foul of the authorities. Land ownership rights are very murky.

Rural communes have become companies with commune members as shareholders — which means nothing has really changed. If this is the position under Putin, imagine how much less economic freedom there was under Yeltsin.

Why then was there so much talk of excessively rapid liberalisation under Yeltsin? Mainly because of a massive, failed privatisation. Ironically, the privatisation was a socialist variety called voucher privatisation.

Instead of auctioning government firms to the highest bidder, all citizens were given shares in government companies, and most sold their shares for a song. The oligarchs controlled banks, and used bank funds to purchase a controlling holding in these giant companies very cheaply.

Often, they looted huge sums from privatised companies, and used this to promote their murky empires and gain political influence. It was like the robber baron phase of American politics in the 19th century.

Unlike Russia , some fragments of the shattered Soviet Union truly have economic freedom. Estonia (6), Lithuania (29) and Latvia (33) rank high in the Index of Economic Freedom. Of former Warsaw Pact countries, Hungary ranks at 44, Slovenia at 62, Poland and Slovakia jointly at 66. All enjoy far higher living standards than Russia .

Putin may have improved conditions in Russia , but has a long way to go before catching up with Russia ‘s former empire.